De Beers vs. The Bear Market: Who Will Win?

June 1, 1995byRussell Shor

The rough-diamond world order has virtually crumbled in the past three years. Journalists have expended thousands of pessimistic words speculating how De Beers will try to reassemble it while the industry grapples with low profits and uncertainty about the future.

Nicholas Oppenheimer, vice chairman of De Beers, acknowledges these are “interesting times” in the Chinese curse sense. But he says De Beers is resourceful and adaptable enough to deal with them.

Oppenheimer and his executive team have their work cut out for them this year. Sales contracts with all the diamond producers in De Beers’ network are due shortly. At issue are contracts with Botswana (17 million carats annually), Russia (9 million), Argyle (40 million) as well as smaller operations; together they comprise more than three-quarters of the world’s rough diamond production. The nature of these five-year contracts – also called marketing agreements – will profoundly affect both prices and supplies of the vast majority of diamonds for the remainder of this dec-ade and beyond.

The last round of contract talks in 1990-’91 occurred against a backdrop of prosperity and rising prices. But times now are different, with the industry demoralized by uncertainty and cash-flow problems. This round of talks focuses on five key issues:

An industry squeezed to the wall with little or no profit, growing consumer price resistance and ever-more reluctant credit sources.

Russian sales of rough diamonds that De Beers Director Gary Ralfe says “make a mockery” of the cartel’s single-channel marketing system and undermine profits and confidence in world diamond centers.

Mountains of very small, low-quality diamonds from the Argyle mine in Australia and a “technical” (industrial) diamond stockpile in Russia with no ready market.

A 15% reduction, imposed several years ago, in the quotas of diamonds De Beers buys from producers in its network.

The future. What will happen in South Africa – the world’s third largest diamond producer – amid social changes there, or in Zaire, wracked by political turmoil but still a major diamond source? What impact might new diamond mines in Canada have?

Timing: When contract talks last began in 1990, the diamond industry was just coming off the biggest expansion in modern history. The market was so hot that rough supplies ran critically short. Top rough dealers went courting top producers such as Botswana, Namibia and Angola, hoping to grab more goods. They made a lot of waves, egging on producers – even those firmly in De Beers’ camp – to clamor for more independence, more money and more “windows,” a term applied to the right to sell a certain percentage (usually 20%-25%) of their production outside the Central Selling Organisation, De Beers’ marketing arm.

Back then, the CSO could take the relatively easy step of mollifying producers by raising prices. Indeed, the CSO had just imposed some of its largest price increases ever – 13.5% in 1988, 15.5% in 1989 and 5.5% in 1990. While the increases largely reflected surging Japanese demand for diamonds, they helped to deflect other producer demands, particularly for outside sales.

Today, the CSO can’t raise prices because events unfolding since 1990 have greatly changed the economic and political order in the diamond world:

First, unraveling economies in the U.S. and Japan, which together account for 59% of world diamond sales, brought price competition, big debt writeoffs, eroding profits and bloated inventories.

Second, the Soviet Union, the world’s largest diamond producer by value, fell apart at the seams; with it went the country’s “old diamond hands,” who rarely questioned their relationship with the CSO.

Third, governments in Angola and Zaire also unraveled. When Angola’s 15-year civil war ended in 1992, more than 50,000 former soldiers streamed onto the diamond fields. Within six months, they dug up some $600 million worth of diamonds, sold them into a market already hit by recession, then fled when the war resumed. Meanwhile, riots and the disintegration of the dictatorship in Zaire allowed huge increases in diamond theft and smuggling.

Fourth, Namibia and South Africa moved to majority rule – without unraveling. All signs point to slowly evolving change, with little or no disruption in diamond operations. In fact, these operations have been revitalized with off-shore mining in both countries and the new Venetia Mine in South Africa.

All of these factors contribute to Oppenheimer’s “interesting times.” But he believes there’s considerable room to maneuver and overcome these problems. “Demand for diamonds isn’t that bad,” he says, “and this gives everyone encouragement.”

The following report offers an in-depth look at the factors affecting the diamond market and comes to this conclusion: it will take some time for De Beers and the CSO to put things back in order. But once they do, look for diamond prices to rise, particularly if demand revives in Japan.

RUSSIA: VEXING MAVERICK

More than $2 billion worth of diamonds came out of Russia in 1994 – about half of them through the CSO. The problem is that most should have gone through the CSO under a five-year marketing contract the Soviet Union signed with De Beers in 1990.

De Beers officials agree that the contract is in a shambles. But they’ve publicly stated their confidence that Russia will sign a new contract by year’s end. They’ve also implied privately they are willing to wait until the country’s vast stockpile is depleted in order to extract the best possible terms.

De Beers also hopes other producers will pressure Russia back into the fold. That’s because Russia’s sales outside the CSO “are detrimental and destabilizing” to the market, says Julian Ogilvie Thompson, chairman of De Beers. “The additional sales by Russia have rendered it impossible [to remove the 15% quota reduction or to increase prices].”

CSO and Russian officials have maintained an official silence on negotiations for a new contract. But De Beers’ primary demands reportedly are:

An end to outside sales (with the possible exception of a 5% “window” like the one allowed in the current pact for local cutters).

That Russia’s large diamond polishing plants get their rough diamonds from the CSO in London instead of directly from Russian production.

An end or sharp curtailment to most joint polishing operations with western companies. De Beers officials say most of these ventures are thinly veiled ruses to leak rough out of Russia outside the CSO.

Russia, meanwhile, reportedly wants the rights to sell more production outside the CSO and to retain unlimited amounts of rough for its polishing plants and joint ventures. Some Russian officials also want seats on De Beers’ board for more access to market information and decision-making.

Complications: The negotiations are complicated by the fact that two agencies with different agendas control Russia’s diamonds.

Almazi-Rossi-Sakha (ARS), which oversees mining operations and markets new production, takes a cooperative view of De Beers’ single-channel market philosophy, though it’s taking a harder line on keeping Russia’s diamond polishing industry and joint ventures supplied with Russian diamonds.

Komdragmet, which maintains the country’s stockpiles of diamonds and gold, has been largely responsible for outside sales of rough. Its chairman, Evgeny Bychkov, openly flouts his independence from De Beers.

De Beers also has to negotiate with Sakha Province, site of all Russian diamond mines, which has its own corresponding agencies. (Under the current contract, Russia gets 80% of all production and Sakha gets 20%. Russia is supposed to sell 95% of its share through the CSO; the other 5% is reserved for local cutters. Sakha sells all of its share through the CSO.)

Further tangling the negotiations is a stock of industrials controlled by a third agency, Tekalmaz, which is governed by Komdragmet. Tekalmaz sold huge amounts of lower-quality cuttable diamonds to Indian manufacturers last year and continues to do so this year.

When contract negotiations began in earnest last year, ARS, Komdragmet and the governments of Russia and Sakha Province formed a committee to present a united front to the CSO. Because of political changes in Russia during the second half of 1994, De Beers’ Director Gary Ralfe says this joint committee hasn’t been able to meet with the CSO since October. However, the CSO has continued discussions more informally with Komdragmet. Additionally, ARS and the CSO have established a working party that has met several times.

Who sold how much? Bychkov told Moscow newspapers that Komdragmet sold $1.05 billion worth of rough and polished diamonds on the open market last year, slightly less than the $1.1 billion that ARS sold through the CSO. In 1993, Komdragmet sold an estimated $350 million on the market.

In deference to these Russian sales, says Ogilvie Thompson, the CSO cut back its own sales about 3% last year. At the same time, worldwide polished diamond sales rose 4%. Says one Antwerp dealer, “It’s surprising because the CSO has said in the past it wouldn’t reduce its own sales to accommodate the Russians. But it appears they’ve done just that in a limited way.”

How much longer Komdragmet will continue its “renegade” sales is the question of the year. The size and makeup of Komdragmet’s stockpile have caused much speculation; De Beers’ officials believe it’s only a matter of time before the stockpile is depleted.

It may not matter anyway. In a significant break from past statements, Ralfe says the CSO might be willing to cut a deal with Russia that doesn’t include Komdragmet or the stockpile. “Of course, we would like to have stockpile diamonds included in the contract, but it’s certainly an option not to,” he says.

Ralfe also stresses that buying Russia’s stockpile is an option. “There is a precedent,” he says. “We took some of it in 1990 [which has been held as collateral for a $1 billion loan] and we are always looking to see how it can be included in our negotiations.”

As for Russian demands to sell a quarter or more of its production on the open market, Ralfe says today’s unprofitable climate is the strongest rationale for the single-channel marketing system. “Producers can see the alternative to single-channel marketing is too ghastly to contemplate,” he says.

Allegations of corruption: A growing undercurrent of corruption charges against Bychkov and Komdragmet is a wild card in the negotiations. Bychkov is a powerful force in Russia with connections to the highest levels of government. His forced resignation would undermine Komdragmet’s autonomy to sell rough diamonds as it pleases.

Russian authorities are investigating him in relation to $88 million worth of rough provided to a Russian/U.S. venture called Golden ADA in San Francisco, Cal. (see “Russian officials probe diamond sales,” JCK, March 1995, page 24). The rough went from Komdragmet’s stock to Golden ADA in early 1994, but the government had received no payment by year’s end. Golden ADA officials – who have not been accused of any wrongdoing – say they’ve been manufacturing the goods and will begin to market them soon.

In addition, dealers in Antwerp and Israel say some joint ventures with foreign companies allow a foreign dealer to buy rough at a favorable price and then export it without having it polished by the Russian partner. That violates Russian policy, but dealers allege that regular bribes and kickbacks to Russian officials make such arrangements possible.

Some Russians maintain there are legitimate reasons to sell from their diamond stockpile. Leonid Gourevich, Bychkov’s deputy, told JCK two years ago the stockpile was a “national asset which should be sold in an orderly, responsible manner” to help ease the nation’s severe financial plight. He and other Russian officials have repeated that assertion many times since then, along with the nationalist view that sales from the stockpile must be matched to their country’s needs, not De Beers’.

Who’s in charge? Because of the cloud over Bychkov and complaints from Russian authorities that Komdragmet has mismanaged stockpile sales, many believe ARS now calls most of the shots. Sergei Oulin, vice president of ARS, has insisted that Russia have more control over its diamond resources, but also has stressed the need to cooperate with the “existing order in the diamond world.” Therefore, ARS is closer to De Beers.

ARS also realizes that Russia’s aging diamond mines, for which it is responsible, desperately need repair and upgrading. Its figures show (and De Beers corroborates) that new production has declined some 40% to about 12 million carats since 1986. Floods and mud put Russia’s first mine, Mir, out of commission, while lack of equipment and capital have caused problems at the Udachnaya and Aikhal mines. Ralfe praised ARS’s “hard work and investment” in keeping these mines running, but says they need “regular, consistent revenue and stable prices” [from the CSO-contracted purchases] to continue that commitment.

Jubilee, another important mine, was supposed to come on stream later this year, but a dearth of equipment and money has delayed construction indefinitely. The recovery plant and operations center lie unfinished; some observers think all machinery and equipment brought there will have to be scrapped because it’s been exposed for years to some of the world’s harshest weather conditions.

Peter Miller, an analyst with Yorkton Securities, Vancouver, B.C., believes these problems – coupled with depletion of the stockpile, which he estimates could come next year – will end Russia’s status as one of the world’s top diamond producers. “Harsh reality indicates the downward spiral in Russian production will accelerate in the next 24 months and possibly remain depressed until well into the next decade.”

Many analysts believe that if Russia’s diamond stocks are removed from the equation, De Beers would use its leverage as the industry’s rich uncle to offer a deal to rehabilitate the mines in exchange for long-term control. Indeed, Ogilvie Thompson says De Beers would consider demands from some Russians to add one of their own to the De Beers or CSO board “if they are prepared to cooperate with us as closely as Botswana and Namibia.” Diamond operations in Botswana and Namibia are owned 50/50 by De Beers and the state governments.

Effect on the trade:There is a danger in the wait-them-out strategy. While it may ensure De Beers firmer control in the long run, it would increase uncertainty in the diamond trade and financial community in the short run.

Des Mayers, an analyst with G. O’Flaherty & Co. in Johannesburg, South Africa, says the Russian problem has caused the value of De Beers’ stock to drop more than 35% in the past 18 months. “Russian sales have caused confidence in the industry to ebb so much that the financial community has completely discounted De Beers’ diamond assets,” he says. De Beers’ share prices now reflect only the value of its non-diamond assets, including investment firms which are part of its sister company, Anglo American Corp., he says. “The market is saying the onus of controlling the Russians and maintaining market stability balances out completely against De Beers’ diamond assets,” he says.

The view within the industry is less cataclysmic. Dealers complain they’ll continue to suffer while De Beers and the Russians play chicken, but they don’t foresee the whole system collapsing.

Much of Russia’s outside rough has been channeled to Israel and Antwerp, where top manufacturers say the resulting oversupplies and inconsistent prices have disrupted the market and undermined prices. “The large manufacturers worldwide have paid a heavy price in order to sustain the high level of diamond prices,” manufacturer Uri Schwartz told the Israeli trade press. “There is no doubt that if the Russians had not sold off some $800 million to $1 billion on the open market, we would not be suffering with the profitability problems we have today.” Nevertheless, Schwartz believes the industry is strong enough to withstand the flood of Russian goods.

In New York, where larger stones rule, manufacturer Jacques Roisen admits there’s some oversupply of rough, particularly in the smaller, lower qualities. But he believes that Russian sales are more hype than threat in the top end of the market. “There’s no oversupply of larger stones,” he says. “With small goods it’s a different story, but psychologically everyone has the feeling there’s an oversupply of everything when that’s not the case.”

AUSTRALIA: SMALL DIAMONDS, BIG PROBLEMS

When Australia’s Argyle mine was commissioned a decade ago, its engineers boasted they’d built the most efficient diamond recovery system in the world. It could sift out virtually every diamond from the host ore and leave virtually nothing but waste rock behind.

Now De Beers executives worry privately that may be too much of a good thing. They call the flood of smaller, lower-quality diamonds the industry’s biggest long-term problem. Indeed, there’s far more coming out than the market can absorb in recession or boom time. While cheaper, affordable small diamonds remain popular in the U.S. and elsewhere, stocks have risen much faster than demand. More importantly, consumers have become more savvy about diamond quality; many no longer want the extremely included smalls (what some Indian dealers call “dead” and “semidead” qualities).

More than half of Argyle’s 40-million-carat yearly output is industrial or near gem (marginally cuttable into gems). Stocks of them are accumulating at CSO headquarters in London, at Argyle headquarters in Perth (because of the CSO’s 15% reduction in producer quotas) and in dealers’ offices throughout India and Antwerp. Add to these the nearly 2 million carats of similar material sold from the U.S. Strategic Stockpile last year and an even greater amount sold by the Russians and the mountain grows pretty big.

Key issue: Though Ogilvie Thompson says the current Argyle agreement is “satisfactory,” the flood of small diamonds will undoubtedly be the key issue when De Beers and Argyle begin negotiating their contract, which expires early next year.

Neither side will comment on specifics yet. But one Argyle consultant, Isi Horowitz of IDH in Antwerp, believes the Australians and the CSO will have to write off a high percentage of the industrials and lowest-quality near gems – especially those under 7 points. “The problem with the Russians is the stockpile, which will run out eventually,” he says. “But Argyle pumps out these very low quality goods with no end in sight. There’s so much that it actually diminishes the value of the rest of Argyle’s production. The only solution is to crush them and stop producing them in the future.”

The crunch, he says, will come when the CSO lifts its quota reduction and is obliged to take these goods. But some analysts speculate writing off such a large amount of production could force Argyle to close or to cancel its plan to move the mine underground within the next five years.

Horowitz doesn’t think so. “Argyle could probably make almost as much money without these goods because market confidence – and then prices for the better rough – would improve.”

Mike Mitchell, general manager at Argyle, doesn’t think so either. He won’t comment on specifics of contract negotiations. But he says the lowest qualities “don’t represent a very important financial component of Argyle’s production” and that Argyle is concentrating on goods that will be visually attractive but inexpensive when polished.

Effect of quota reduction: Mitchell concedes De Beers’ 15% quota reduction has cut Argyle’s sales volume. But he says cutbacks and improved efficiency have made up for the loss. “The overall effect on our bottom line has been minimal,” he says.

Neither has the quota forced Argyle to cut back its substantial promotions through the Indo Argyle Council, which helps 16 large Indian diamond jewelry manufacturers sell their products in the U.S. and other major markets. Argyle helps these manufacturers develop export-quality jewelry made largely with lower-quality Argyle-mined diamonds. It also helps by taking space in all major U.S. jewelry trade shows.

In addition, De Beers’ Consumer Advertising Division has launched marketing programs in China, India and several Asian nations to build markets for very low quality diamonds, but says meaningful progress remains years away. Mitchell is more optimistic, saying rapid growth of these markets will help clear out excess stocks of small goods.

BOTSWANA & MARKET ‘WINDOWS’

The biggest challenge to De Beers’ single-channel system used to come from its own backyard, notably Botswana. The southern African nation produces about 16 million carats of diamonds worth $1.5 billion each year, second only to Russia, in a 50/50 partnership with De Beers. When the current contract was being negotiated five years ago, Botswana’s parliament considered a proposal to sell 20% of its output on the outside market.

The idea was dropped and hasn’t been revived for this round of negotiations, says Baldezi Gaolathe, managing director of the joint venture, called Debswana. “We found we were getting the best deal in the long run from the CSO,” he says. Since the last negotiations, Botswana also has “beefed up our machinery to check prices and market conditions to ensure we’re getting the best deal.”

(Some producers do have limited rights to sell outside the CSO. Russia’s government, as already noted, may sell 5% of its share of rough under a contract that expires in December. It also may retain an unspecified percentage for polishing. Australia’s Argyle Diamonds may sell 25% of its industrials and near gems through its own office. However, Argyle is a special case because its parent companies, notably Ashton Mining, operate in the U.S. That means selling the entire Argyle output through the CSO could run afoul of U.S. antitrust laws.)

Another issue in Botswana, a diamond stockpile worth an estimated $500 million, is also on the back burner this time around, says Gaolathe. The stockpile was amassed 12 years ago when the market for better quality diamonds crashed and De Beers reduced the number of diamonds the CSO bought from producers. Three years later, Botswana’s leaders, facing a loss of income from their country’s only real source of funds, pressured De Beers into taking oversight of the stockpile, which remained in Debswana’s Orapa House headquarters in Gabarone. In exchange, Debswana received a block of De Beers stock and two board seats.

De Beers imposed another reduction in quotas three years ago (25% the first year; 15% since then). But Botswana’s leaders are more patient now because the nation’s economy has diversified (diamonds now represent 40% of the gross domestic product, down from 70% a decade ago) and because communication between De Beers and the government has improved.

Gaolathe also says there’s no pressure from the government or the trade to sell from the stockpile. “If all major producers including ourselves were tempted to sell,” he says, “the market would be adversely affected – to the detriment of all of us.”

NAMIBIA: DE BEERS LOOKS TO THE SEA

Next door in Namibia, De Beers has slammed the door on anyone looking for more outside rough. Late last year, De Beers gave the government half interest in its mining operations and an equal management role in exchange for 25-year mining rights and what De Beers calls the best offshore mining concessions.

Shortly before Namibia gained its independence in 1990, leading rough diamond dealers from around the world met with the country’s leaders in hopes of luring some diamonds away from De Beers, which owned the mines outright at the time. It was a tempting prize because Namibia remains the single top source for high-quality diamonds and has potentially rich offshore deposits.

Many analysts expected the new government to take the route of most African nations – nationalize the mines and throw diamond marketing into a free-for-all. But the new leaders maintained an enigmatic silence on a mining and minerals policy for three years before starting talks with De Beers in 1993.

Abel Gower is director of Namdeb, the partnership that replaced CDM, De Beers’ Namibian subsidiary. He says much of the government’s rhetoric in those early meetings tilted toward nationalization;”There was a lot of talk early on about exploitation of their resources.” But Gower says two factors turned the tide: convincing Namibia’s leaders that De Beers wasn’t as bad as they believed and showing them that CDM already gave the government some 70% of its revenue in taxes and export duties. Once that was accomplished, the issues became management and employment, not money.

For De Beers, the deal giving Namibia half interest in the coastal mines was a wash; the value of the holdings and lower income was offset by an appropriate reduction in tax liabilities. The government now can appoint half of Namdeb’s directors. “Eventually, Namibians will also take over mining operations, but there’s no set timetable,” Gower says. For now, De Beers has held onto three key positions: chairman of Namdeb, manager of the mine and chairman of the management committee, which oversees day-to-day operations.

Analysts criticized the deal, saying De Beers gave away half of a valuable resource for no compensation. Gower responds that the 25-year hold on the best diamond mining areas and continued exclusive sales through the CSO are more important in the long run. He also believes the agreement will help bring peace and stability to contentious labor relations. The mines had been plagued by periodic labor stoppages, “but now that the government has an interest in the mine, it also has an interest in maintaining labor peace,” he says.

The government also now has an interest in security and enforcing laws against anyone caught stealing diamonds from the shallow beach mine operations. Such thefts have claimed an estimated 10% or $25 million worth of Namibia’s diamond output in recent years.

Offshore deposits: Namibia’s coastal mines are in their declining years; their 1993 yield slid nearly a half-million carats to 774,000. But Namibia likely will remain a major diamond producer for years to come thanks to new technology that allows mining deeper offshore deposits. Some geologists believe untold riches – as much as half-a-billion carats – lie waiting for mining ships to pick them up.

Gower calls such estimates outrageous. “Obviously, there are diamonds there,” he says. “But nowhere near the quantities given by some people.” De Beers started deep-water mining in Namibia in 1991 and estimates it hauled about 400,000 carats from the ocean floor last year. That was up 50% from 1993, largely because an eighth mining ship was added to its fleet.

Graham Rees, general manager of Debmarine, the De Beers ocean mining operation, says that shallow deposits immediately offshore were exhausted in the 1970s. His company spent the next 15 years prospecting deeper waters 20-60 miles out to sea. “We’ve been very systematic and have a pretty good idea of what’s there,” he says.

The ships dig the ocean floor 300 feet below almost constantly; refueling and restocking are done at sea. Miners use drills attached to long cables to break up sediment and overburden on the ocean floor and bring it to the surface through huge vacuum hoses. The material is screened for waste rock and other debris, with the remaining concentrate sealed into fruit-cocktail-sized tin cans and carried off the ships to Namdeb’s sorting facility in Windhoek.

Rees says technology is improving all the time. “We’re now working on a multiple crawler that can conduct several digging operations at once,” he says. That could allow mining of areas not economically feasible otherwise.

What about the future? “We mine about 1.5 square kilometers each year,” says Rees. “Our concession is 26,350 square kilometers, so we’ve obviously got a lot of reserves out there.”

SOUTH AFRICA: OFF THE RADICAL ROAD

Without a doubt, De Beers’ greatest challenge in future years will be its home turf in South Africa.

The nation remains De Beers’ “spiritual” home, is where the Oppenheimer family resides and has become a resurging diamond producer thanks to the new Venetia mine, which produced 5 million carats last year. (De Beers’ South African assets account for 20% of its total assets.)

While the ruling African National Congress Party believes changes are needed in South Africa’s mining sector, the good news for De Beers is that the ANC has ruled out radical measures such as nationalizing mines. However, it does want more opportunity for new and smaller players. Currently, most of the nation’s vast mineral wealth is held by a few huge conglomerates – such as De Beers and its related company, Anglo American Corp. – that have kept viable deposits under wraps for years.

Marcel Golding, an ANC member of South Africa’s parliament and chairman of the government’s Mineral and Energy Select Committee, says such concentration is both good and bad.

It’s good because conglomerates have the huge capital resources needed to explore and sustain mining operations. It’s bad because the conglomerates have essentially shut out smaller companies. “If you are talking about free market competition, we need some here,” he says.

Golding stresses there’s no talk of breaking up conglomerates – as some of his colleagues had suggested earlier. But he says mining laws must be revised to allow opportunities for newcomers. “For example, many countries tax unused mineral claims as an inducement for companies to free areas they don’t plan to develop right away. Then those rights can go to smaller companies.”

In addition, the ANC is seeking ways to raise employment and revenue without stopping companies from making further investments in their operations. “We don’t want to raise input costs on mining companies that would discourage development of mineral deposits, and we realize we can’t tax the rich until they squeak,” he says. “But we do want a fair tax burden that could allow us to provide change in a stable environment.

“Remember, democracy is a costly form of government.”

Golding also says South Africa must attract new foreign investment and stresses that a favorable tax structure isn’t the only thing companies look at when considering a move. “They want political stability, a pool of skilled managers, skilled labor, good infrastructure and available capital,” he says. “We have these now.”

Political changes: Golding’s views, which he admits do not represent all factions of his party, are relatively mild compared with the Marxist-style proclamations by ANC members several years ago. Indeed, South Africa’s transition to majority rule has been a near miracle, averting the bloody ethnic warfare raging in so many other African countries. Along the way, the majority ANC has transformed its platform from Socialist-style expropriation to an egalitarian free market system.

De Beers and Anglo American Corp. were intimately involved in both developments. Before the ANC came to power in 1994 elections, South Africa teetered on the edge of violence as Mongosuthu Buthelezi, leader of the Inkatha Freedom Party and the Zulu Nation, threatened to pull out of the election process and take Natal Province with him. As Inkatha and ANC forces engaged in increasingly bloody confrontations, ex-De Beers Chairman Harry Oppenheimer personally intervened, flying Buthelezi and Nelson Mandela, head of the ANC and now South Africa’s president, to his suburban Johannesburg home to hammer out an agreement. Both sides say the meeting saved the elections and very possibly prevented civil war.

The transformation of the ANC from socialism to free market was no less remarkable. The party’s minerals policy, drafted in the 1960s, was summed up in one sentence: “Mineral rights shall be transferred to the people as a whole.”

The change began in 1985 when Anglo Director Gavin Relly and other top executives defied a government ban on contact with the ANC and journeyed to Zambia to meet with the party’s exiled leaders. “It became apparent the ANC had no consistent, coherent economic policy and even more apparent it needed one,” says Michael Spicer, a senior adviser to Anglo. “We’ve had constant and quite rigorous contact with the ANC ever since.”

The process was formalized in 1990 after Mandela was released from prison and the ANC was allowed to function as a legitimate political organization. Business, government, labor and ANC leaders formed the National Economic Forum to lay out a foundation for economic policy. “Sectors met constantly to iron out issues and communicate,” says Spicer. “There was a constant flow of ideas, and all parties changed their positions substantially. All sides now understand the requirements of power and limits of government.”

Since the 1994 election, these groups have widened the scope to include how business and government can redirect resources to improve education, health and living conditions in black areas of the country. This is called the Reconstruction and Development Plan.

Blacks in business: While the ANC moved from Marx to mainstream, business also moved a great deal, says Spicer. “Business has come to realize the free market cannot endure for long if all South Africans cannot participate in the economy,” he says. “This means an equity employment system – based equally on U.S.-style affirmative action and on merit – an acceptance of black trade unions and programs to stimulate black businesses.”

For several years, De Beers/Anglo has operated the Small Business Initiative, which taps black-owned business for support services and subcontracting. Anglo’s biggest effort at black economic empowerment is the spinoff of Johannesburg Consolidated Investment, one of the nation’s largest mining finance houses with substantial interests in gold mining, platinum mining and other mineral operations. Each of these three divisions has assets of about US$1 billion.

Anglo has begun to sell 48% of its JCI Ltd. and Johnnies Industrial Corp. divisions in a program targeted at black investors. The remainder will be sold to institutions. Spicer says blacks will be able to buy into the divisions through consortia formed from pension fund savings, church groups and savings funds. He acknowledges that involving blacks in one of the country’s largest mining houses is largely symbolic for the population as a whole. “Still, it’s important to involve black South Africans more fully in every facet of business,” he says.

The two divisions also will come under black management eventually, though no timetable has been set.

In addition, De Beers and Anglo have set a 50/50 white/non-white target for recruiting their own employees, though Spicer says everything is based on merit.

Anglo also contributes about $20 million yearly to education and community development programs through its Chairman’s Fund.

“There are no easy answers, but we do expect reasonable progress,” says Spicer. “Many will say we are not doing enough and we understand this, so we have to satisfy ourselves that we are doing the best we can.”

The aspirations of blacks in the poorest areas of the country remain relatively low and attainable, say Anglo and ANC officials. “Basically, they want better water and sanitation,” says Golding. “That will keep us on our toes. But if we can achieve real results, we can make [democratic] government work.”

Another major concern is unemployment. Labor Minister Tito Mboweni says 3.6 million people are without work; more than half of them are under 30 years old. Mboweni, like Anglo executives, rejects old-style public “make work” projects and subsidized employment as unworkable. “The government can only aim to ensure the highest possible [private sector] growth rate that is reconcilable with available resources,” he says, “and that will stimulate creation of jobs.”

Looking ahead: The future of South Africa remains an enigma. Many South Africans worry the country will splinter along ethnic lines or fear protracted ethnic violence. In addition, Buthelezi’s quest for an independent Natal Province has not ended. Most government and business leaders believe it will heat up as the committee drawing up a new constitution progresses.

Golding is optimistic. He believes the current government – which will hold power until the new constitution is ready in about two years – can overcome these challenges and continue its peaceful transition if it remains open, relatively corruption-free and responsive to the legitimate needs of people.

But South Africa is a long way from complete reconciliation, he says. “First, we have to change the culture of most South Africans from one of opposition to one of participation by showing them they have a stake in government. Second, while we recognize that South African business is a necessary partner, it’s often very slow to change and has accomplished things by force, not necessarily with violence, but with no debate or argument. We must replace this culture with one where discussion and debate are the rule.”

Nicholas Oppenheimer believes South Africa faces many problems ahead as it “tries to break the mold.” But he’s optimistic it will stay on the democracy road. “The government has been successful in its first year and has been able to meet the expectations of most groups,” he says. “I strongly believe South Africa will grow in importance in the years ahead.”

ZAIRE & ANGOLA: OUT OF THE EQUATION?

If South Africans ever need examples of what corrupt governments and civil war can do to potentially rich nations, they need look no farther than two diamond powers to their north.

Zaire’s economy has been driven to near shutdown by a long standoff between dictator Mobutu Sese Seko and a rival government led by Kengo wo Dondo. Official diamond production at MIBA, owned 80% by the government and 20% by Sibeka of Brussels, has fallen to half of 1990 levels. And Geca Mines, a giant copper mining group that once accounted for 60% of the nation’s export income, now accounts for just 6%.

The outlook for a resolution anytime soon is bleak. Bruno Morelli, a MIBA board member, says diamond production has stabilized at 4.8 million carats annually, but he’s not optimistic about the future. The main problem: the government has rescinded a tax break instituted after production took a nosedive in 1993. “In the previous two years, Zaire authorities allowed us to postpone payment of export taxes on diamonds,” says Morelli. “This year, they want $11 million paid against total revenues of $15 million.”

As a result, MIBA will be unable to buy new equipment or spare parts to keep the mine fully operational. “Mining is expensive and needs constant repair or replacement of equipment,” Morelli says. “Without the funds to do that, things deteriorate rapidly.” Before the tax men came calling, MIBA had forecast output of 5.5 million carats this year and 7 million by decade’s end. “Those numbers are impossible now,” he says.

In addition, supplying the 5,000 mine workers and their families in the remote fields north of Mbuji is expensive and dangerous. The military and corrupt local militia constantly hijack supply convoys, then sell the supplies elsewhere, according to mining officials.

Production control: MIBA doesn’t even have a formal diamond marketing contract, though it sells all of its output through the CSO. The only formal agreement involves setting an average floor price (currently $10.71 per carat) for its total output, which is 60% industrial.

Zaire still produces lots of diamonds – more than 20 million carats yearly. The official production at MIBA totals about 4.8 million carats and itinerant diggers working private claims unearth about 9 million. The rest – invariably the best quality stones – is smuggled out through countries with no export duties.

These “informal” sectors comprise the largest single source of rough traded outside the CSO. But De Beers generally considers this no threat because the stones invariably are traded through established, stable channels. Indeed, a fair portion of these goods reach De Beers through indirect routes.

However, corruption in the informal sector has gone far beyond control and is now linked to money laundering, counterfeiting, drug dealing and other illegal activities. Dealers say many of Zaire’s leaders and military are involved.

Because of such corruption and Mobutu’s refusal to yield to a fledgling democratic movement, no one is optimistic that Zaire’s “official” diamond production will recover anytime soon. “As long as there’s this mentality that the chief can take everything,” says Morelli, “nothing will change.”

Problems in Angola: Bleak though Zaire’s outlook is, it’s still better than neighboring Angola’s, where official production has nearly ceased with no prospects of restarting. Peter Gush, who heads De Beers’ diamond operations in South Africa, believes illicit diamond digging several years ago seriously damaged the country’s diamond-producing potential.

During a brief 1992 respite in the country’s decades-long civil war, thousands of diggers invaded the main mining area of Cuango. “The diggers essentially picked the eyes out of every viable diamond deposit,” he says. Their inefficient methods took only the larger stones, rendering the rest of the area uneconomical to mine.

The diggers dumped nearly $1 billion worth of high-quality diamonds onto the world market. De Beers reportedly bought about two-thirds of them to prevent inundating the market.

Then the rebel group UNITA bolted from the peace process, seized control of Cuango and continued mining the area itself. “There is no reason to believe they were any more efficient,” says Gush.

Today, UNITA is in a shambles after taking several hard hits from government forces. The violence has left the Cuango fields too dangerous to mine. In fact, UNITA hasn’t put any diamonds on the market since fall, says Georges Evens, an Antwerp dealer long active in Angola. There is, however, some formal mining in the old diamond fields of Lucapa, he says. “I can’t disclose how much. But it’s fairly insignificant when considered against what was coming out years ago.”

The problems in Angola have scuttled plans to develop a large diamond-bearing formation at Catoca, which had been billed as a major new find six years ago. Tests have shown it’s much lower grade than Angola’s other diamond production, says Gush, and would pose serious development problems even under much better circumstances.

Evens adds that Catoca or any other deposit would require a great deal of foreign investment. “There’s no interest in doing that now,” he says. “Everything is in a shambles, and there’s no sign it will get any better.”

CANADA: HOPE FOR THE FUTURE

Canadian diamond production is a big question mark in De Beers’ future.

One proven mine has been found in the Lac de Gras area of the Northwest Territories, just below the Arctic Circle. And several potential sites are in the later stages of exploration. There’s also a lot of stock market hype, so analysts still are trying to sort out reality from rhetoric.

BHP/DiaMet, with the one proven mine, has made no announcements about marketing its production and its officials decline to comment. Production, due to begin in about three years, is projected at about 2 million carats yearly – primarily smaller, good-quality diamonds.

Analysts believe the CSO will get some portion of BHP/DiaMet’s production, but not all of it. The reasons are complex.

First, BHP and its exploration partner DiaMet, which owns 29% of the venture, may be entitled to separate shares of the mine’s production under Canada’s mining law. BHP is an Australian company with North American headquarters in the U.S., where antitrust officials have taken an aggressive stance against De Beers’ market dominance.

Second is an intangible factor that one analyst calls “corporate ego.” Because mining houses generally are very competitive, some believe BHP would be reluctant to sell its diamonds through its rival, De Beers. This is the rationale of a treatise by Geoffrey Leggett, a director of an independent rough diamond dealer based in London, who predicts that the world’s rough diamond market eventually will be ruled by several large production/trading blocs instead of De Beers’ single channel. Leggett believes that BHP would have the resources to become a third force in rough diamonds along with the CSO and an independent Russia.

A well-respected consultant adds that BHP probably would have little trouble marketing its goods outside the CSO if it chose to do so. “They have used a number of big Antwerp dealers to evaluate their exploration samples, so they’ve already established a network of dealers who would love to handle their production,” says the consultant.

Courting in Canada: De Beers executives have made regular journeys to Canada to meet with BHP and local and federal government officials. They say they would like very much to have marketing rights to BHP’s production. But they are careful to draw a distinction between the BHP situation and a seemingly similar one when the Argyle diamond mine was being developed 15 years ago.

Argyle’s senior partners, CRA and Ashton Mining, considered De Beers a competitor and were reluctant to sign over their production to the CSO. It took some hard-as-nails talk by Harry Oppenheimer, then chairman of De Beers, to bring Argyle into the network. In BHP’s case, however, the expected 2-million-carat production is less than 2% of world output and, unlike Argyle, would not disrupt De Beers’ diamond order if sold outside the CSO.

This would change if several mines eventually come on stream, as many predict. Then De Beers would have to come to terms with companies backed by corporate parents as large as itself. Indeed, a report from analyst Peter Miller of Yorkton Securities says Canada will have at least three other major working diamond mines by the end of this decade or shortly thereafter, making it one of the world’s largest diamond-producing nations.

Others, including De Beers, believe such predictions are premature, if not exaggerated. One De Beers executive says all of the diamond-bearing kimberlite pipes found in Canada thus far have been very small in diameter, making them expensive to work because they must be mined in clusters rather than individually. In addition, environmental effects are a concern in several diamond areas, where mining will have to be approved by local and/or federal authorities. So whether Canada’s diamond finds end up being economical remains a question mark.

PRICES & PROFITS

While the world press grapples with speculation over the Russians’ next move and what changes will come with all the producers’ next contracts, the gut issue for the industry remains terrible profits and cash flow.

Nicholas Oppenheimer, vice chairman of De Beers, says the CSO is maintaining a very difficult balance between the producers’ desire to maximize returns and the industry’s need to make a profit. “We’ve been telling our producers there has to be profitability all the way down the line or no one will be able to do business in the long run.”

Producers say they’ve gotten the message – for now at least. Until January, the premium (average markup) on boxes of diamonds at each CSO sight allocation was about 2%, meaning only a fraction could be sold and cut profitably. But then the CSO adopted a much leaner mix, tailored very closely to specific sizes and qualities that sightholders could cut and sell profitably. Rough diamonds for which there is no market are being held back.

Oppenheimer says the favorable sights will continue. “It’s what we’ve got to do,” he says. “We’ve got to ensure our clients’ loyalty and long-term future by giving them goods they can make and sell profitably.”

Diamond manufacturers welcome the change, though many say it’s belated. They also have no illusions that profits will improve quickly. “This situation has gone on for three years and this is the first time they’ve really tried to do anything,” says one top U.S. sightholder. The market remains too slow and too competitive to permit increases in margins, the sightholder says.

Caught in the middle: Many dealers say they’ve been caught in the middle of a power struggle between two diamond giants – De Beers and Russia.

“Each year, it seems the CSO pushes the rough market very hard until it cannot absorb any more to keep clients from buying Russian goods,” says Georges Evens. This top Antwerp rough diamond dealer believes a credit crunch may be in the offing.

Like De Beers, the Russians take only cash. “Most, if not all, Russian rough is bought with borrowed funds,” says Evens. “That’s why it comes on the market so quickly. Dealers have to move the goods fast to pay back the banks.”

Indeed, dealers in every major diamond center say banks have become worried that profits haven’t improved while business expenses have risen.

Bankers and dealers agree that most major lenders to the industry remain patient with the top, well-capitalized companies, but smaller and marginal operations may see strict limits on their credit lines. “That will definitely slow things down in the near future,” says Evens. “That’s because everybody has to buy in cash and sell on credit.”

PRODUCERS AND POLISHING PLANTS

One issue likely to come up more than once in De Beers’ negotiations with producers involves help in launching local polishing industries.

De Beers already has helped Botswana build a diamond polishing plant – a hot issue in the last round of negotiations – to increase employment and add value to its resources. Namibia and South Africa are pressuring for the same. Russia was able to extract a promise to help build a polishing plant, though the idea was later abandoned.

Even though the demands are widespread, De Beers remains reluctant to yield to them. “The realities are that any polishing operations, particularly large-scale ones, would have to compete with the well-established factories in India,” says Peter Gush, head of De Beers’ South African diamond operation. “Can they meet India’s wages and productivity without some kind of subsidy? It’s hardly likely.”

The only chance a local polishing plant has in an intensely competitive market is as a limited operation that fills a market niche, he says. The Teemane Diamond Factory in Botswana is just such an operation, and even it is “still moving toward viability” three years after opening, says Gush. Still, the plant does well because it found a market niche for 7- to 11-point rough with an emphasis on good make, says De Beers Director George Burne. All of the production goes to two U.S. firms: a corporate gift manufacturer in Salt Lake City, Utah, and a large diamond house in New York City.

Located in the center of the country near the village of Serowe, the plant employs 330 women (“no men applied for the jobs,” says one De Beers official). The highly automated operation turns out about 1,100 finished diamonds daily – about 40% of its potential. Botswana officials have made it clear they will seek more plants if Teemane becomes a flying success.

Botswana also has a larger diamond polishing plant, a $3 million facility established by Lazare Kaplan International, New York City. The plant, located in Molepolole, employs about 450 people and has been in full operation for about 18 months, says LKI President Leon Tempelsman. Productivity is growing on schedule, he says. “Remember our [local] workers were largely untrained, but they have learned very quickly.”

When LKI proposed the plant in 1990, the government turned down its request for rough diamonds from the country’s production to run it. But De Beers later agreed to provide enough “to meet the financial and performance objectives set by the Botswana government.”

Meanwhile, De Beers Chairman Julian Ogilvie Thompson says the cartel “would do all it can” to revive the diamond polishing industry in South Africa, but cautions that the country’s wages are too high to compete with other polishing centers.

To encourage domestic diamond manufacturing, some government officials say they are looking at reviving a rough diamond export duty removed a decade ago.

POWER SHARING & THE CSO

The entry of world-class mining companies into diamond exploration and the independence of the Russian stockpile have brought talk that De Beers’ Central Selling Organisation eventually will have to share some of its market with other large blocs. De Beers, quite naturally, disagrees.

In the short run, some knowledgeable sources believe the Russians will remain a permanent and strong “second force” competing with De Beers. Geoffrey Leggett, a director of the London-based Industrial Diamond Co., an independent dealer of rough diamonds, speculates that De Beers’ loss of full control of Russia’s production, coupled with a likely independent Canadian production, “will significantly dilute” De Beers’ strength in the future.

If a rough diamond market divided among several large mining blocs such as BHP and the Russians replaced the CSO’s near monopoly, control could be maintained just as easily, argues Leggett. But the smaller firms who would be selling to a larger number of clients could be more flexible in meeting market requirements. This would end the need for the “artificial” and complex system of sightholders, “official” price increase announcements and rough assortments which Leggett claims are more in tune with the CSO’s needs than with the trade’s.

Peter Miller, an analyst with Yorkton Securities, Vancouver, B.C., poses a similar argument, noting that other large mining companies may eventually buy into the CSO by taking blocs of De Beers shares. “Like it or not, the CSO is going to have to evolve into some kind of producers’ cooperative as opposed to today’s marketing cartel,” he says. “The appearance of [large companies] such as BHP and Kennecott suggest the death knell for yesterday’s policies of rigid inflexibility.”

However, the sharing will have to go two ways, he says: “In a reformed CSO, producers can be expected to bear their appropriate share of costs of diamond advertising and stockholding.”

De Beers’ view: It’s not impossible that a power-sharing system could evolve years down the line, says Nicholas Oppenheimer, vice chairman of De Beers. But it’s De Beers’ challenge to convince producers that single-channel marketing is the way to go, he says.

The key is to be flexible enough to deal with changes. “All one really knows,” he says, “is that business doesn’t stand still.”

Oppenheimer cites one example of how the CSO has responded to producers’ desire to be closer to the diamond market. “For many years, we purchased diamonds from Diamang, which marketed all of Angola’s diamonds. It was basically a purchase agreement; we bought their diamonds but had little else to do with them. Debswana, however, represents a drastic changeellipse There’s a full partnership and endless consultations on many issues.”

Indeed, Oppenheimer points to Debswana as the perfect example of how the CSO can share power. “The government of Botswana acquired shares in De Beers and with them the right to sit on De Beers’ board,” he says.

Oppenheimer believes adding a producers’ council to advise or supervise the CSO as a bloc, as some have suggested, would be unworkable. “It would simply add bureaucracy to an efficient organization,” he says. “We are a major diamond producer ourselves, and that’s what sets up apart from a group like the OPEC oil cartel, which is simply a bureaucracy.”